Crypto Staking – The Islamic Perspective + Investing options - IslamicFinanceGuru — Islamic Finance Guru (2024)

The rise of crypto-assets has given us new ways to make money. Staking is increasingly becoming popular now and there is a lot of money to be made. But the key question remains: is it halal?

In this article we cover:

1. What staking is and how it works
2. The Islamic perspective on staking
3. What are the best options available to engage in staking

What is staking?

There are currently two main ways of adding a ‘block’ to a blockchain.

1) Proof of Work (PoW)

2) Proof of Stake (PoS)

The most famous example of the proof of work system is Bitcoin. In this model, you use computing power to solve increasingly difficult mathematical puzzles to add a new block to the chain. By doing this you are rewarded with a coin.

The problem with this is the inefficiency and the cost of electricity required to mine new blocks because of having to solve increasingly difficult maths puzzles using increasingly powerful computers.

Proof of stake is a more efficient alternative to this.

In a proof of stake system users who own some of the cryptocurrency ‘lock’ or hold their funds in a wallet. Instead of having to solve maths puzzles to add blocks to the chain, users are selected at random based on how much currency they have locked up.

The user who is chosen at random is rewarded with a coin. Typically, how it works is the more coins you hold the more you can ‘earn’, so the size of your stake is directly proportional to the chances of being chosen to forge the next block and earning coins.

Staking in a nutshell: lock up your coins to earn coins.

The Islamic Perspective on Staking

Staking as a concept is not Islamically problematic. It is simply a rule-based approach used by a crypto project to decide who will get the right to add to the blockchain.

The IFG Fatwa Forum has covered the point briefly here.

There are a few important caveats to make here:

1. Each crypto project has its own specific staking dynamics and so the particular rules of a crypto project may not necessarily be sharia-compliant if they throw in something novel. However, if they use very straightforward staking concepts, that should be fine.
2. Staking is just a mechanism of creating new coins in a crypto project. You also need to make sure that the crypto project itself is sharia-compliant. So, for example, if a crypto project links itself directly with gambling, then regardless of how it uses staking, it will be imper.

However staking must not be confused with liquidity mining or yield farming. Not all liquidity mining or yield farming is necessarily sharia-compliant.

The reason why the confusion arises is that both staking and liquidity mining involves investors buying and holding cryptocurrencies and getting a return for it. However, what is actually generating those returns under the hood are very different.

We will cover liquidity mining and yield farming in a separate article but a high-level summary is that liquidity is very helpful in crypto projects as it allows them to function.

Two core places liquidity can be very helpful is by allowing the exchange of cryptocurrencies and by allowing the lending out of cryptocurrencies. If you don’t have liquidity, then exchanging and lending become very difficult.

It is therefore not surprising that the two main sources of liquidity mining or yield farming seek to allow the flourishing of an ecosystem that either facilitates brokerage/exchange of cryptocurrencies or lending of cryptocurrencies.

The latter is, rather unsurprisingly, impermissible, while the former is in principle permissible. However, as with all things crypto, the devil is in the detail and each new crypto project should be examined from first principles.

IFG have prepared a list of the top 50 cryptocurrencies (by market cap) and shared our preliminary sharia assessment of these cryptocurrencies.

Things to consider before staking

What should you look out for when thinking about where to stake?

Returns

Of course, the primary incentive to stake is for the passive income it generates.

The reward from staking is dependent on many factors. The most important one being the network’s protocol.

In addition to the protocol and price, different exchanges and platforms may differ in the percentage they offer when it comes to staking, so doing your own research is important to see how you can maximise your returns.

You also don’t want to invest just for the staking rewards whilst the coin itself loses a lot of value. It is important to conduct some due diligence on the network and coin.

You would also need to hold some significant number of coins to see real returns.

Liquidity

Cryptocurrencies are still very much a new type of investment, being available for just a few years for retail investors.

There are an increasing number of new currencies launching every day. It is important to ensure the that the coin you invest in is liquid and can be bought and sold easily.

The last thing you want is for your investment to be illiquid and highly volatile and not being able to convert to cash when you need to.

Keep this in mind especially when putting money into lesser-known altcoins. Lower liquidity will also have an impact on volatility, so you may see massive swings in the value of your coins which may end up negating any staking rewards.

Ease

There are new protocols and projects popping up in the crypto world every day.

To engage in staking for some of the more obscure coins some amount of technical expertise is required in setting up the infrastructure and connecting your wallet and computer.

However, the more well-known coins are available to stake on world-renowned exchanges such as Coinbase and Binance, where millions of people around the world buy and sell crypto every day.

These exchanges take care of all the infrastructure and technical aspects when it comes to buying and selling crypto and package it in a user-friendly UI.

Of course, this ease of use comes with significant fees.

Fees

An important factor to consider when staking is the fee taken by an exchange or wallet which can eat into your returns.

Firstly, you need to consider the fees charged as soon as you make a purchase of any coins. Most exchanges have a spread fee as well as a purchase fee. You also need to consider fees linked to methods of payment and withdrawal, such as debit card fees.

Most importantly, you should look into the staking fee charged. Typically, how it works is the exchange you hold your coins with distributes the staking reward to you minus the commission, which can be as high as 25% at high-tier exchanges like Coinbase!

Tax

Since trading and staking crypto is an investment, different governments and jurisdictions have been slowly adapting tax law in this direction.

In the UK for example, crypto exchanges offer fully taxable accounts since there is no ISA equivalent for a crypto at this moment in time.

Staking is treated as miscellaneous income according to HMRC and would be taxed as such for the average retail investor. It is essential you keep any tax implications in mind.

What are the best options for staking?

Ethereum 2.0

Ethereum is the second most popular cryptocurrency. By staking Ethereum, you help the system scale and flourish.

To do it alone you need to have at least 32 ETH, but many exchanges and platforms usually allow people with less than 32 ETH to stake together in staking pools.

At the moment, Ethereum 1.0 is based on the proof-of-work system and so cannot be staked. Ethereum 2.0 hasn’t been launched to the mass market yet, though it is possible to stake it on Binance if you’re willing to lock up your coins until the launch of 2.0.

The APY is around 5%.

(N.B. Do not confuse staking pools with liquidity pools – as that is another crypto concept – see above introduction)

Tezos (XTZ)

Tezos was created in 2018 and is one of the more popular options for staking. At the time, Tezos received over $230 million in investment.

Tezos uses a version of PoS called liquid proof-of-stake (LPoS).

In the Tezos network, staking is called ‘baking’. People who bake are rewarded with the XTZ coin. Any malicious activity can result in your stake being confiscated.

To become a baker, you usually need to hold 8,000 XTZ coins. However, third party services allow smaller bakers to pool together funds to share in the rewards of baking.

Various exchanges allow baking for a retail investor, such as Coinbase and Binance.

The annual percentage yield (APY) on XTZ is around 5-6%.

Algorand (ALGO)

The aim of the Algorand protocol is to facilitate low-cost cross-border payments. It’s another popular option with many cryptocurrency exchanges offering the ability to stake for smaller amounts.

The APY can differ depending on the platform or exchange you use to stake, but it can range from 5-10%.

As mentioned above, it’s worthwhile looking for exchanges with low fees and high APY offerings to maximise your staking reward.

Cosmos (ATOM)

Cosmos is an exciting project that aims to create a ‘network of networks’. Its goal is to allow different blockchains to communicate with each other.

Essentially, the end goal with the Cosmos network is to almost create an internet of blockchains to achieve true decentralisation.

By staking the ATOM coin you help sustain and grow the Cosmos network, contributing to their decentralised vision.

ATOM staking is a popular option offered by many exchanges. The APY can go up to 9.7%, though some exchanges offer an average of around 5%.

Cardano (ADA)

Founded by one of the co-founders of Ethereum, the Cardano network positions itself as a new generation Ethereum.

The Cardano network is being developed based on peer-reviewed research and aims to be the mainstream network for smart contracts, just like Ethereum.

At the moment, most of its applications lie in identity management and traceability.

Cardano works on a timeframe called an ‘epoch’, which is five days. It takes three epochs for you to start generating returns by staking ADA.

ADA can be traded through popular exchanges such as Coinbase and Binance.

VeChain (VET)

Taking inspiration from Ethereum, VeChain was founded in 2015 to provide a crypto backbone to enterprise across the world.

VeChain applies the distributed ledger technology of cryptocurrencies to supply chain management and business processes in diverse markets and sectors. It is essentially blockchain-as-a-service.

The network has two currencies, VET and VTHO. VET is the public facing currency that is used as a store of value whereas VTHO is needed to interact with the VeChain network and pay fees if you want to use the blockchain.

VET is available to purchase through Binance. Staking VET will reward you with around 3% APY.

There has been a noticeable downward trend in staking rewards, so take that into account.

Binance Coin (BNB)

Binance is the world’s largest cryptocurrency exchange.

In 2017, they launched an initial coin offering (ICO) for their own coin, Binance Coin.

BNB can be used in certain ecosystems and websites which accept BNB, such as games and communities based on the Binance smart chain or companies willing to accept BNB as payment.

Most importantly, BNB is used within the Binance crypto exchange itself by millions of users to pay fees and donate on Binance charity.

Binance have established an incentive to use BNB for all Binance users because if you pay for trading and transaction fees using BNB, you receive a discount compared to paying with cash.

BNB can be staked on Binance itself, with the APY ranging anywhere from 8% to 27% based on the duration and amount held.

Concluding Thoughts

Coinbase and Binance are the most reputable cryptocurrency exchanges and are used by millions of people across the world. Check out our writeup on how to invest in crypto the halal way.

Check out our IFG Halal Crypto list where we share our own Sharia screening of the top 50 cryptocurrencies.

You can also check out our comprehensive Halal cryptocurrency guide for more details.

For more information on key cryptocurrency topics, please check out our crypto page here.

Finally, our own investment platform Cur8 Capital provides access to Sharia-compliant, institutional-grade investments in Venture and Real Estate Capital on both web and mobile apps. You can explore opportunities provided by Cur8 Capital here.